Retirement Savings: The Key Role of Voluntary Savings
UBS’s recent International Pension Gap Index study compares the pension systems of 25 markets based on the voluntary savings contributions required of their participants.
It notes that, in many systems, private savings are crucial for maintaining one’s standard of living in retirement. Furthermore, the study highlights the importance of retirement planning and emphasizes that investments can often help fill gaps in retirement savings.
The International Pension Gap Index, published by the Chief Investment Office (CIO) of UBS Global Wealth Management (UBS GWM), analyzes the mandatory component of 25 pension systems, focusing on the benefits that workers can expect and the additional savings needed to maintain their current standard of living in retirement.
More specifically, the study compares pension systems based on the savings effort required of a fictional character, measured by the portion of current after-tax income that a female employee must save each year from age 50 until retirement, assuming she has no prior savings.
The results vary considerably from one city to another. For example, private savings are not necessary in Amsterdam, whereas in Tokyo they account for 93% of wages, which is impossible. This is mainly because the Japanese system is not designed to replace a large portion of earned income, unlike the Dutch system, a fact also reflected in its relatively high pension contribution rates. In addition, Japanese people spend 50% more time in retirement than their Dutch counterparts, as they retire earlier and live longer.
Unlike in the Netherlands, private savings are necessary to ensure a certain standard of living after retirement in most cities around the world. The amount depends on the model of the pension system in question. While some systems require little personal commitment from their participants, others place greater emphasis on personal responsibility—that is, they do not aim to maintain a standard of living.
Retirement benefits are rarely guaranteed
Even when expected retirement benefits are high, they can be uncertain if they depend on the performance of financial markets or if the promised benefits are based on outdated demographic and financial assumptions. This is particularly true for certain defined-benefit plans, which may not be able to fulfill their promises as they no longer reflect actuarial reality.
In particular, as the large cohort of baby boomers retires, existing unresolved imbalances are likely to widen in pay-as-you-go pension plans that are already struggling. To keep these systems financially afloat without reducing the pensions of current retirees, today’s workers may be required to foot most of the bill. Consequently, the authors argue that precautionary savings are advisable to mitigate the uncertainty inherent in the reforms.
There are sustainable pension plans
However, some countries have successfully taken steps to address the financial difficulties facing pay-as-you-go basic pension systems. For example, in Sweden, basic pensions are subject to a sustainability safety net that ties pension indexation to the system’s financial stability.
“Looking at what has been implemented in certain countries shows that it is possible to increase the resilience of pension systems without compromising the adequacy of benefits,” says Elisabeth Beusch, an economist at UBS.
The Importance of Retirement Planning
In some cities, the estimated required savings rate far exceeds the savings potential of a worker earning a median income. Faced with this reality, one option is to scale back one’s lifestyle in order to afford retirement. Retiring later or moving to a less expensive location in retirement are also options. However, these difficult decisions can usually be avoided by starting to save early.
Although saving is a necessity, investing can be very beneficial, even if it involves risks. For example, the authors state that in Switzerland, nine times out of ten, investing savings in a diversified portfolio of bonds and stocks would yield better financial results than keeping the money in cash.
Furthermore, relying solely on cash holdings in Switzerland would increase the required savings rate by one-third. “Far from being imprudent, investing savings for retirement can help workers maintain their usual standard of living in retirement,” explains James Mazeau, an economist at UBS.
Should women plan differently?
Pension systems are generally gender-neutral, except when women can retire earlier than men while receiving the same level of benefits. Nevertheless, women tend to take career breaks and work part-time more often than men—for example, to care for their children. As a result, they often experience slower wage growth, accumulate fewer retirement benefits, and save less throughout their working lives.
In addition, women tend to live longer than men. As a result, women generally have fewer resources to fund longer retirement periods. This means that women generally need to save more than men.
